Interest rate forecasts are garbage and best ignored

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nisiprius
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Interest rate forecasts are garbage and best ignored

Post by nisiprius » Fri Aug 07, 2015 8:55 am

A report by the Council of Economic Advisors, Long-Term Interest Rates: A Survey has already been discussed here, but I wanted to call special attention to one chart. Let me state the moral first.

Moral: Ignore all the poobahs making confident-sounding predictions about interest rates, even when it is clear that they are highly knowledgable, and even when it is "everybody" saying so. Listen if you like, but do not act on these predictions. Over the last twenty years, taking action on the basis of the best expert predictions would have always been worse than staying the course and acting as if things wouldn't change.

The colored lines show the predictions that economists made of the 10-year Treasury rates. The blue line shows what actually happened.

Image

So, this is economists versus reality on the ten-year Treasury rate--which is probably the most relevant datum to investors in funds like Total Bond. Over a period of fifteen years, not one single forecast was even qualitatively correct. Not even close. They were all just about as wrong as wrong can be. That's economists predicting 10-year rates.

A lot of years, and a lot of "wrong."

The reasons can be argued, the "wrong" is a simple fact.

Now, the relationship between the overnight rate the Fed sets and the longer-term rates that matter to me is very tenuous, but it's often brought up because people will say that, unlike the 10-year rate, the Fed rate "can only go up" and therefore seems to be predictable. I've previously posted a chart Vanguard included in its one of its white papers. This is the Fed rate, and in this case the predictions are not by economists, but by the market itself. Every place you see hair sticking out from the main line is a place where the market predictions were wrong, and the best summary is "almost everywhere." The market doesn't know, either.

Image
Last edited by nisiprius on Sun Aug 09, 2015 7:42 am, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Beliavsky
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Re: Interest rate forecasts are garbage and best ignored

Post by Beliavsky » Fri Aug 07, 2015 9:14 am

Thanks for the informative message showing how economists have failed to predict 10-year yields, almost always overpredicting them. Investors who ignore forecasts will often set their asset allocation based on historical return data. They implicitly forecast that future asset returns will have the same distribution as past asset returns. You cannot entirely do away with forecasts.

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Re: Interest rate forecasts are garbage and best ignored

Post by rca1824 » Sat Aug 08, 2015 1:28 pm

Doesn't Efficient Market Hypothesis say that any anticipated future movement in interest rates would acted upon instantaneously and thus already be embedded in the current price? Ditto with "expected inflation".

If you knew with full certainty that interests were going to move you could trade derivatives and make extraordinary profit. Only by doing so you would affect the price today. So only the first actor can make a profit.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB

garlandwhizzer
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Re: Interest rate forecasts are garbage and best ignored

Post by garlandwhizzer » Sat Aug 08, 2015 1:55 pm

Great post, nice. Thanks.

Garland Whizzer

jimkinny
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Re: Interest rate forecasts are garbage and best ignored

Post by jimkinny » Sat Aug 08, 2015 2:36 pm

Always good to be reminded of what should be a foundation of any investment plan and that is to ignore forecasts.

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Taylor Larimore
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Two kinds of forecasters.

Post by Taylor Larimore » Sat Aug 08, 2015 2:37 pm

Bogleheads:
"There are two kinds of forecasters: Those who don’t know, and those who don’t know they don’t know.” -- John Kenneth Galbraith, famed economist
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Interest rate forecasts are garbage and best ignored

Post by hafius500 » Sat Aug 08, 2015 4:09 pm

Every place you see hair sticking out from the main line is a place where the market predictions were wrong, and the best summary is "almost everywhere." The market doesn't know, either.
If the market was efficient, it would make the 'best' prediction. It would not be less informed than the representantive investor.
prior username: hafis50

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Hodor
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Re: Interest rate forecasts are garbage and best ignored

Post by Hodor » Sat Aug 08, 2015 4:20 pm

A great reminder that trying to time the bond market is just as futile as trying to time the stock market.

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patrick013
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Re: Interest rate forecasts are garbage and best ignored

Post by patrick013 » Sat Aug 08, 2015 4:45 pm

Well the Federal Reserve determines the actual interest rate.

When they say they are raising the rates in the coming years the
4-5 star long-term bond fund ads start to be seen in the papers.

Going anything but short-term now doesn't make cents to the dollar.

It's not market timing just some positioning to be able to go longer when
nice without having to lose some principal to do so.
age in bonds, buy-and-hold, 10 year business cycle

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nisiprius
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Re: Interest rate forecasts are garbage and best ignored

Post by nisiprius » Sat Aug 08, 2015 5:18 pm

patrick013 wrote:Well the Federal Reserve determines the actual interest rate.
It determines the overnight rate. Actually two overnight rates, the Fed Funds rate and the discount rate.

I don't borrow money overnight. My financial destiny is much more closely tied to the 10-year Treasury rate than to the overnight rate.

The 10-year Treasury rate is set by the market at auction, and the link to the overnight rate is very loose. The Fed does not control the interest rate that matters to me, and it doesn't necessarily influence it very much.

From July 2, 2003 to August 31, 2006
--the Fed raised their rate from 0.87% to 5.05%.
--The 20-year rate rose from 4.54% to 4.95%.
That is, the Fed raised their rate by over 4% and the 20-year rate rose less than 0.5%.
When they say they are raising the rates in the coming years the 4-5 star long-term bond fund ads start to be seen in the papers.
The Fed doesn't raise "interest rates," they raise an interest rate. OK, two rates--the Fed Funds rate and the discount rate, but both overnight.
It's not market timing just some positioning to be able to go longer when nice without having to lose some principal to do so.
Of course it's market timing. You think it's justifiable market timing, possibly prudent market timing, but it's market timing.

Just as some hope to be in the start market whenever it's rising and out of it whenever it's falling, you hope to be in shorter-duration funds whenever interest rates are rising and longer-duration funds whenever they are falling. You believe that listening to the cryptic, hedged hints the Fed gives about overnight rates will enable you to predict what happens to longer-term market-based rates, and thus successfully time the bond market. The economists who made all of the grotesquely wrong predictions on my original chart were listening to everything the Fed was saying for nineteen years, and apparently it didn't help them predict the 10-year Treasury rate.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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patrick013
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Re: Interest rate forecasts are garbage and best ignored

Post by patrick013 » Sat Aug 08, 2015 6:11 pm

What you are talking about was when long term bond rates
were lower than short term bond rates.

Not a normal yield curve or in accordance with liquidity preference
theory. Probably the result of info from Fed Reserve meetings
releases to the public that their schedule was to raise then lower
interest rates, so the long term rates for 10 year was in accordance
with their planned setting of the national interest rate in the future per their
printed forecast and schedule.

Long term should be higher than short term barring any other plans by
the Fed Reserve for setting the national interest rate.

Raise the discount rate by 1% and 1 yr. Cd's will raise their yields by about
1%. Longer bonds will raise yields always higher than shorter term
bonds in a normal market with normal govt. rate setting. Otherwise,
the CD's and bonds just won't sell expecting a normal yield curve and
bond issuers competing for investor's dollars.

Supply and demand has an effect on rates also but not so great as the Fed.

Long story short.
age in bonds, buy-and-hold, 10 year business cycle

Browser
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Re: Interest rate forecasts are garbage and best ignored

Post by Browser » Sat Aug 08, 2015 6:46 pm

"Interest rate forecasts are garbage and best ignored", as opposed to which other forecasts that are not garbage and should be heeded?
We don't know where we are, or where we're going -- but we're making good time.

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Re: Interest rate forecasts are garbage and best ignored

Post by The Wizard » Sat Aug 08, 2015 6:53 pm

Browser wrote:"Interest rate forecasts are garbage and best ignored", as opposed to which other forecasts that are not garbage and should be heeded?
I would say the Boglehead consensus forecast of where the S&P 500 will end up each New Year's Eve is the primo financial forecast, to which we should all pay attention...
Attempted new signature...

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nisiprius
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Re: Interest rate forecasts are garbage and best ignored

Post by nisiprius » Sat Aug 08, 2015 7:20 pm

Browser wrote:"Interest rate forecasts are garbage and best ignored", as opposed to which other forecasts that are not garbage and should be heeded?
Yes, you are correct. I picked on interest rates because a) lately there is a lot of attention being given to interest rate forecasts, and investors seem to be talking about acting on them, and b) I ran across a chart that I thought was really stunning and worth sharing.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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patrick013
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Re: Interest rate forecasts are garbage and best ignored

Post by patrick013 » Sat Aug 08, 2015 7:54 pm

Image

Here's a Fed chart. Not by economists, forecasters, or whatever. Based
on info supplied by the Fed Reserve. Barring an inverted bond yield curve
caused by a recession (very rare), 10 year TRSY should pay 4%, based on
the historical spread between the Fed rate and the 10 year TRSY yield.
Perhaps 5% in 2018 as also expected thru Fed Reserve info only.

So I want liquid cash in my VG brokerage account to do so in 2017 and 2018.

Don't be too discouraging, I even need the money. My other funds had good
entry points and are sitting happy. :D

Just FYI.
age in bonds, buy-and-hold, 10 year business cycle

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Taylor Larimore
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Boglehead Contest forecasts ?

Post by Taylor Larimore » Sat Aug 08, 2015 8:08 pm

The Wizard wrote: I would say the Boglehead consensus forecast of where the S&P 500 will end up each New Year's Eve is the primo financial forecast, to which we should all pay attention...
The Boglehead Contest may be the best financial forecast, but what we can learn from it is that financial forecasts are usually wrong--especially at the individual level.

Best wishes.
Taylor
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Rainier
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Re: Interest rate forecasts are garbage and best ignored

Post by Rainier » Sat Aug 08, 2015 8:24 pm

patrick013 wrote:Well the Federal Reserve determines the actual interest rate.

When they say they are raising the rates in the coming years the
4-5 star long-term bond fund ads start to be seen in the papers.

Going anything but short-term now doesn't make cents to the dollar.

It's not market timing just some positioning to be able to go longer when
nice without having to lose some principal to do so.
Definitely not. The free market determines interest rates.

If you had a few hundred billion you could influence interest rates as well.

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patrick013
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Re: Interest rate forecasts are garbage and best ignored

Post by patrick013 » Sat Aug 08, 2015 9:19 pm

Rainier wrote:
patrick013 wrote:Well the Federal Reserve determines the actual interest rate.
Definitely not. The free market determines interest rates.
Supply and Demand could affect the rates but only up to about a
25% factor. Quantitative Easing doesn't always happen.

Federal Reserve sets the base short-term interest rate for the
national short term interest rate for the domestic yield curve
to set the yields in market equilibrium where supply=demand
at various rates. Basic Finance theory. I see it happen all the time.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Interest rate forecasts are garbage and best ignored

Post by neurosphere » Fri Aug 21, 2015 4:46 pm

nisiprius wrote:
The colored lines show the predictions that economists made of the 10-year Treasury rates.

Image
I wonder if anyone who made a prediction of rising rates last week, would make the same prediction today, based on the events of the last few days (declines in the stock market and decreases in the rates of longer-term debt).

We may have very low rates across the yield curve for quite a long time yet. Or we may not. I don't know. No one does.

In 2005 I was quoted in a national financial magazine of saying "A 3.5% fixed rate is just not a good deal". I was referring to the new fixed rate EE savings bonds. The author of the article then went on to write "This is especially true now, because most experts expect rates to rise". Uh huh. 10 years later and rates are even lower.

So, I've learned not to make predictions, especially not to the press or on the internet. :D

To be fair, I was comparing the new 3.5% fixed EE rate savings bond to an I-bond with a 1.2% fixed rate, and thought that the I-bonds were a better deal. In retrospect, 3.5% EE bonds, tax deferred, would have had a very respectable place in many portfolio. Also, to be fair, I was just going along with the story the reporter was trying to write. So I stuck with her narrative in order to get my name and photo in a magazine. ;)
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patrick013
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Re: Interest rate forecasts are garbage and best ignored

Post by patrick013 » Fri Aug 21, 2015 5:04 pm

Now that quantitative easing has stopped or at least tapered off
regarding treasuries, there should be more supply of treasuries
in the secondary market. Buyers should buy at a more normal
term premium and keep the yield curve upward sloping I would
think.

Quantitative easing in itself can make the yield curve quite flat.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Interest rate forecasts are garbage and best ignored

Post by Waba » Fri Aug 21, 2015 9:18 pm

hafius500 wrote: If the market was efficient, it would make the 'best' prediction. It would not be less informed than the representantive investor.
Why do you believe it is _less_ informed? Where do you see better predictions? Just because the market prediction is utterly wrong doesnt mean by itself that it wasnt still the _best_ prediction. It just means that rates are not very predictable.

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